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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to .
-------- --------
Commission File No. 0-31157
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2507402
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation)
720 Pennsylvania Drive, Exton, Pennsylvania 19341
(Address of principal executive offices) (Zip Code)
(610) 646-9800
(Registrant's telephone number, including area code)
Indicate by check mark whether registrant (1) has filed all reports required to
be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
As of February 10, 2003, there were 12,705,890 shares of the Registrant's Common
Stock, with par value of $.001, outstanding.
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
FORM 10-Q December 31, 2002
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS (unaudited)
Condensed Consolidated Balance Sheets - September 30, 2002 and December 31, 2002.................. 3
Condensed Consolidated Statements of Operations - Three Months Ended December 31, 2001 and 2002... 4
Condensed Consolidated Statements of Cash Flows - Three Months Ended December 31, 2001 and 2002... 5
Notes to Condensed Consolidated Financial Statements.............................................. 6-7
Item 2. MANAGAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.......................................................................... 7-12
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........................................ 12
Item 4. CONTROLS AND PROCEDURES........................................................................... 12
PART II OTHER INFORMATION................................................................................. 12
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS......................................................... 12
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................... 12
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.................................................................. 12
Signatures.................................................................................................. 13
2
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
September 30, December 31,
2002 2002
------------- ------------
ASSETS
Current Assets:
Cash and cash equivalents ...................................................... $52,245,754 $52,952,298
Accounts receivable, less allowance for doubtful accounts of $100,000 at
September 30, 2002 and December 31, 2002, respectively ...................... 5,300,421 3,849,516
Inventories .................................................................... 3,352,649 3,278,593
Deferred income taxes .......................................................... 650,384 650,384
Prepaid expenses ............................................................... 655,869 559,562
----------- -----------
Total current assets ........................................................ 62,205,077 61,290,353
----------- -----------
Property and Equipment:
Computers and test equipment ................................................... 3,261,588 3,295,897
Corporate airplane ............................................................. 2,998,161 2,998,161
Furniture and office equipment ................................................. 517,129 517,129
Manufacturing facility ......................................................... 6,389,935 6,389,935
----------- -----------
Total property and equipment ................................................... 13,166,813 13,201,122
Less-Accumulated depreciation and amortization ................................. (3,021,918) (3,185,363)
----------- -----------
Net property and equipment ..................................................... 10,144,895 10,015,759
----------- -----------
Deposits and Other Assets ......................................................... 266,713 515,494
----------- -----------
Total Assets ................................................................... $72,616,685 $71,821,606
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Current portion of note payable ................................................ $ 100,000 $ 100,000
Current portion of capitalized lease obligations ............................... 17,111 11,707
Accounts payable ............................................................... 246,814 304,142
Accrued expenses ............................................................... 2,416,719 2,129,022
Accrued income taxes ........................................................... 128,190 117,636
Deferred revenue ............................................................... 137,936 150,436
----------- -----------
Total current liabilities ................................................... 3,046,770 2,812,943
----------- -----------
Note Payable ...................................................................... 4,235,000 4,235,000
----------- -----------
Deferred Revenue .................................................................. 402,877 385,259
----------- -----------
Deferred Income Taxes ............................................................. 205,828 205,828
----------- -----------
Commitments and Contingencies
Shareholders' Equity:
Preferred stock, 10,000,000 shares authorized--Class A Convertible stock,
$.001 par value; 200,000 shares authorized, no shares issued and
outstanding at September 30, 2002 and December 31, 2002 ...................... -- --
Common stock, $.001 par value; 75,000,000 shares authorized, 12,802,069 and
12,701,013 shares issued at September 30, 2002 and December 31, 2002,
respectively ................................................................ 13,052 13,057
Additional paid-in capital ..................................................... 46,093,605 46,133,926
Retained earnings .............................................................. 19,869,553 20,093,239
Treasury stock, at cost ........................................................ (1,250,000) (2,057,646)
----------- -----------
Total shareholders' equity .................................................. 64,726,210 64,182,576
----------- -----------
Total Liabilities and Shareholders' Equity ..................................... $72,616,685 $71,821,606
=========== ===========
The accompanying notes are an integral part of these statements.
3
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended Three Months Ended
December 31, 2001 December 31, 2002
------------------ ------------------
Revenues .................................... $ 7,308,466 4,422,795
Cost of Sales ............................... 2,730,129 2,042,998
----------- -----------
Gross Profit ................................ 4,578,337 2,379,797
----------- -----------
Research and Development .................... 1,127,735 927,302
Selling, General and Administrative ......... 1,637,883 1,254,143
----------- -----------
Operating Income ............................ 1,812,719 198,352
Interest Income ............................. 241,440 182,929
Interest Expense ............................ 26,243 37,149
----------- -----------
Income Before Income Taxes .................. 2,027,916 344,132
Income Tax Expense .......................... 750,329 120,446
----------- -----------
Net Income .................................. $ 1,277,587 $ 223,686
=========== ===========
Net Income Per Common Share
Basic .................................... $ 0.10 $ 0.02
Diluted .................................. $ 0.10 $ 0.02
Weighted Average Shares Outstanding
Basic .................................... 12,932,565 12,711,403
Diluted .................................. 13,155,063 12,942,990
The accompanying notes are an integral part of these statements.
4
INNOVATIVE SOLUTIONS AND SUPPORT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
For the Three Months For the Three Months
Ended December 31, Ended December 31,
2001 2002
-------------------- --------------------
Cash Flows From Operating Activities:
Net income ................................................................. $ 1,277,587 $ 223,686
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization .............................................. 222,038 179,277
Loss on disposal of fixed assets ........................................... 15,088 11,113
Stock issued to directors .................................................. 39,000 40,326
(Increase)/decrease in -
Accounts receivable ........................................................ (2,385,130) 1,450,905
Inventories ................................................................ 53,618 74,056
Prepaid expenses and other ................................................. (344,335) (155,474)
Increase/(decrease) in -
Accounts payable ........................................................... 520,932 57,328
Accrued expenses ........................................................... 1,004,007 (298,251)
Deferred revenue ........................................................... (93,217) (5,118)
----------- -----------
Net cash provided by (used in) operating activities .................. 309,588 1,577,848
----------- -----------
Cash Flows From Investing Activities:
Purchases of property and equipment ........................................ (2,568,980) (58,255)
Restricted cash ............................................................ 317,465 0
----------- -----------
Net cash (used in) provided by investing activities ........................ (2,251,515) (58,255)
----------- -----------
Cash Flows From Financing Activities:
Repayments of capitalized lease obligations ................................ (5,398) (5,403)
Purchase of treasury stock ................................................. (1,250,000) (807,646)
----------- -----------
Net cash (used in) provided by financing activities ........................ (1,255,398) (813,049)
----------- -----------
Net (Decrease) Increase In Cash and Cash Equivalents ........................... (3,197,325) 706,544
Cash and Cash Equivalents, Beginning of Year ................................... 42,769,837 52,245,754
----------- -----------
Cash and Cash Equivalents, End of Period ....................................... $39,572,512 $52,952,298
=========== ===========
The accompanying notes are an integral part of these statements.
5
Innovative Solutions & Support Inc,
Notes to Condensed Financial Statements
1. Basis of Presentation:
Innovative Solutions and Support, Inc., (the "Company"), was incorporated in
Pennsylvania on February 12, 1988. The Company's primary business is the design,
manufacture and sale of flight information computers, electronic displays and
advanced monitoring systems to the military, government, commercial air
transport and corporate aviation markets.
The balance sheet as of December 31, 2002, the statements of operations for the
three months ended December 31, 2001 and 2002 and the statements of cash flows
for the three months ended December 31, 2001 and 2002 have been prepared by the
Company without audit. In the opinion of management, all adjustments, consisting
of normal and recurring adjustments, necessary to present fairly the financial
position, results of operations and cash flows at December 31, 2002 and for all
periods presented have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted. It is suggested
that these financial statements be read in conjunction with the financial
statements and notes thereto included in the Company's Form 10K for the year
ended September 30, 2002 as filed with the Securities and Exchange Commission.
The results of operations for the three months ended December 31, 2002 are not
necessarily indicative of the operating results for the full year.
2. Initial Public Offering and Treasury Stock
In August 2000, the Company completed its initial public offering of 3,450,000
shares of Common Stock at a price of $11.00 per share. The Company received net
proceeds of approximately $34 million from the offering. Upon the closing of the
offering, the outstanding shares of Preferred stock were converted into
1,941,353 shares of Common stock.
In December 2001, the Company purchased 250,000 shares of its stock at a cost of
$1,250,000. On June 6, 2002, the board of directors authorized an open-market
stock repurchase program of up to 2,000,000 shares of its common stock. In the
quarter ended December 31, 2002 the Company purchased an additional 106,300
shares at a cost of $807,646.
3. Net income per Share
Net income per share ("EPS") is calculated using the principles of SFAS No. 128.
On July 7, 2000, the Company's Board of Directors approved a split of the
Company's common shares on a 1.09624-to-1 basis. All references in the financial
statements to the number of common shares and to per share amounts have been
retroactively stated to reflect the common share split.
A reconciliation of weighted average shares outstanding appears below:
Three months ended
December 31,
-----------------------
2001 2002
---------- ----------
Weighted average shares outstanding:
Basic ............................................. 12,932,565 12,711,403
Potentially dilutive securities:
Employee Stock Options ............................ 37,158 34,858
Warrants .......................................... 185,340 196,729
---------- ----------
Weighted average shares outstanding:
Diluted ........................................... 13,155,063 12,942,990
========== ==========
The weighted average number of shares for potentially antidilutive employee
stock options was 319,030 as of December 31, 2002.
6
4. Concentrations
During the three months ended December 31, 2002 and 2001, the Company derived 0%
and 64% of its revenues from one customer, respectively. Accounts receivable
related to this customer totaled $0 at December 31, 2002. The Company's supply
arrangement with this customer was completed in the third quarter of fiscal
2002. In the quarter ended December 31, 2002 the Company derived 12%, 11%, 17%,
and 17% of revenue from four customers.
5. Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market and
consist of the following:
September 30, December 31,
2002 2002
------------- ------------
Raw materials ................................... $1,981,989 $1,697,096
Work-in-process ................................. 836,017 621,798
Finished goods .................................. 534,643 959,699
---------- ----------
$3,352,649 $3,278,593
========== ==========
6. Warranty
The estimated cost to repair or replace products under warranty are provided
when sales of product are recorded.
Warranty accrual at September 30, 2002 .......... $ 675,640
Warranty expense ................................ 48,226
Warranty costs .................................. (25,190)
----------
Warranty accrual at December 31, 2002 ........... $ 698,676
==========
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
We design, manufacture and sell flight information computers, electronic
displays and advanced monitoring systems to the military, government, commercial
air transport and corporate aviation markets.
Our revenues are derived from the sale of our products to the retrofit market
and, to a lesser extent, original equipment manufacturers (OEMs). Our customers
include government and military entities and their commercial contractors,
aircraft operators, aircraft modification centers and various OEMs. Although we
occasionally sell our products directly to government entities, we primarily
have sold our products to commercial customers for end use in government and
military programs. These sales to commercial contractors are on commercial
terms, although some of the termination and other provisions of government
contracts are applicable to these contracts.
We record revenues when our products are shipped. Since fiscal year 1998, the
majority of our revenues have come from the sale of Reduced Vertical Separation
Minimum (RVSM) compliant air data systems, including sales to commercial
contractors in connection with the United States Air Force KC-135 retrofit
program. We were the sole supplier of these systems and components under
subcontracts with various commercial contractors for the retrofit program, which
covers the approximately 600 KC-135 aircraft currently in use. With the
exception of spare part and on-going repair effort, the Company's existing
supply arrangement with this customer was completed in the quarter ended June
30, 2002.
We continue marketing our flat panel display system, or Cockpit Information
Portal (CIP), and are in the process of obtaining the required certifications.
We expect to begin recording revenues from our flat panel display in the first
half of fiscal year 2003.
Our cost of sales are comprised of material components purchased through our
supplier base and direct in-house assembly labor and overhead costs. Because our
manufacturing activities consist primarily of assembling and testing components
and
7
subassemblies and integrating them into a finished system, we believe that we
can achieve flexible manufacturing capacity while controlling overhead expenses.
In addition, many of the components we use in assembling our products are
standard, although certain parts are manufactured to meet our specifications.
The overhead portion of cost of sales is primarily comprised of salaries and
benefits, building occupancy, supplies, and outside services costs related to
our production, purchasing, material control and quality departments as well as
warranty costs.
We intend to continue to invest in the development of new products and the
enhancement of our existing product line. We expense research and development
costs related to future product development as they are incurred.
Our selling, general and administrative expenses consist of marketing and
business development expenses, professional expenses, salaries and benefits for
executive and administrative personnel, facility costs, and recruiting, legal,
accounting and other general corporate expenses.
Three Months Ended December 31, 2002 Compared to the Three Months Ended December
31, 2001
Revenues. Revenues decreased $2.9 million, or 39%, to $4.4 million for the three
months ended December 31, 2002 from $7.3 million in the three months ended
December 31, 2001. The decrease in revenue was primarily the result of
completing all KC-135 deliveries in fiscal 2002 where $4.7 million was realized
in the quarter ended December 31, 2001 as opposed to no KC-135 revenue in the
period ended December 31, 2002. Revenue unrelated to the KC-135 program
increased $1.8 million or 68% to $4.4 million for the three months ended
December 31, 2002 from $2.6 million in the three months ended December 31, 2001.
Cost of Sales. Cost of sales decreased $687,000, or 25%, to $2.0 million, or
46.2% of revenues, in the three months ended December 31, 2002 from $2.7
million, or 37.4% of revenues, in the three months ended December 31, 2001. The
decrease in dollar amount of cost of sales was related to our decrease in
revenues. As a percentage of revenue, cost of sales increased from 37.4% in the
three months ended December 31, 2001 to 46.2% in the three months ended December
31, 2002. This percentage increase was essentially the result of absorbing the
same amount of overhead expenses on lower sales volume.
Research and development. Research and development expenses decreased $200,000
or 18% to $927,000 or 21% of revenue in the three months ended December 31, 2002
from $1.1 million or 15% of revenue in the three months ended December 31, 2001.
The decrease in dollars was the result of $252,000 of Non Recurring Engineering
(NRE) direct cost deferred on the balance sheet as it relates to deferred
revenue associated with customer paid NRE. The increase as a percent of revenue
was principally the result of lower revenues in the period.
Selling, general and administrative. Selling, general and administrative
expenses decreased $384,000, or 23%, to $1.3 million, or 28.4% of revenues, in
the three months ended December 31, 2002 from $1.6 million or 22.4% of revenues,
in the three months ended December 31, 2001. The decrease in dollar amount was
the result of lower consulting and commission expenses. The percent to revenue
increase was due to lower revenue in the period.
Interest income. Interest income was $183,000 in the three months ended December
31, 2002 as compared to interest income of $241,000 in the three months ended
December 31, 2001. The decreased interest income in the three months ended
December 31, 2002 was primarily the result of lower interest rates in the
period.
Interest expense. Interest expense was $37,000 in the three months ended
December 31, 2002 as compared to $26,000 in the three months ended December 31,
2001. The increase was due to the fact that interest is no longer being
capitalized as part of the cost of the company's new manufacturing facility. The
facility was placed into service in November 2001.
Income tax expense. Income tax expense was $120,000 in the three months ended
December 31, 2002 as compared to income tax expense of $750,000 in the three
months ended December 31, 2001. The decrease was primarily due to lower income
before taxes in the period. Of the $630,000 reduction, however, $7,000 was the
result of lowering the effective tax rate from 37% in the three months ended
December 31, 2001 to 35% in the three months ended December 31, 2002.
Net income. As a result of the factors described above, our net income declined
$1.1 million or 83%, to $0.2 million, or 5% of revenues.
Liquidity and Capital Resources
Our main sources of liquidity have been cash flows from operations, borrowings
and the proceeds of our initial public offering in August 2000. We require cash
principally to finance inventory, accounts receivable and payroll.
8
Our cash flow provided from operating activities was $1.6 million for the three
months ended December 31, 2002 as compared to $0.3 million for the three months
ended December 31, 2001. The improvement was mainly the result of a $3.8 million
improvement in accounts receivable that more than offset a $1.3 increase in
accrued expenses and $1.0 million in lower net income.
Our cash used in investing activities was $58,000 for the three months ended
December 31, 2002 as compared to $2.3 million for the three months ended
December 31, 2001. The decrease in the three months ended December 31, 2002 was
primarily due to the Company's completion of its new manufacturing facility in
the prior year.
Net cash flow used in financing activities was $813,000 for the three months
ended December 31, 2002 as compared to $1.3 million in the three months ended
December 31, 2001. This primary use of cash in both periods was to acquire
treasury stock; $808,000 in the period ended December 31, 2002 for 106,300
shares and $1,250,000 for 250,000 shares in the period ended December 31, 2001.
Our future capital requirements depend on numerous factors, including market
acceptance of our products, the timing and rate of expansion of our business and
other factors. We have experienced increases in our expenditures since our
inception consistent with growth in our operations, personnel and product line,
and we anticipate that our expenditures will continue to increase in the
foreseeable future. We believe that our cash and cash equivalents, together with
the net proceeds from our initial public offering will provide sufficient
capital to fund our operations for at least the next twelve months. However, we
may need to raise additional funds through public or private financings or other
arrangements in order to support more rapid expansion of our business than we
anticipate, develop and introduce new or enhanced products, respond to
competitive pressures, invest in or acquire businesses or technologies or
respond to unanticipated requirements or developments. If additional funds are
raised through the issuance of equity securities, dilution to existing
shareholders may result. If insufficient funds are available, we may not be able
to introduce new products or compete effectively in any of our markets, which
could hurt our business.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amount of revenues and expenses during the
reporting period. The most significant estimates and assumptions relate to our
allowance for doubtful accounts, inventory reserves and warranty reserves.
We maintain an allowance for doubtful accounts for customer returns and for
estimated losses resulting from the inability of our customers to make required
payments. These allowances are determined by analyzing historical data and
trends. If actual losses are greater than estimated amounts or if the financial
condition of our customers were to deteriorate, resulting in an impairment of
their ability to make payments, future results from operations could be
adversely affected.
Inventories are written down for estimated obsolescence equal to the difference
between the cost of inventory and the estimated net realizable value based upon
assumptions about future market conditions. If actual future demand or market
conditions are less favorable than those projected by management, additional
inventory write-downs may be required.
We offer warranties on some products of various lengths. At the time of
shipment, we establish a reserve for the estimated cost of warranties based on
our best estimate of the amounts necessary to settle future and existing claims
using historical data on products sold as of the balance sheet date. The cost of
warranties is affected by the length of the warranty, the product's failure
rates and the customer's usage. If the actual cost of warranties differs from
our estimated amounts, future results of operations could be adversely affected.
Business Segments
The Company operates in one principal business segment which designs,
manufactures and sells flight information computers, electronic displays and
advanced monitoring systems to the Department of Defense, government agencies,
commercial air transport carriers and corporate/general aviation markets. The
Company currently derives virtually all of its revenues from the sale of this
equipment. Almost all of the Company's sales, operating results and identifiable
assets are in the United States.
New Accounting Pronouncements
In December 2002, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 148 "Accounting For Stock-Based Compensation - Transition an Disclosure, an
amendment of FASB Statement 123. SFAS No. 148 addresses alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, this Statement amends the
disclosure requirements of Statement 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting for
stock-based compensation and the effect of the method used on reported results.
This Statement is applicable for interim periods beginning after December 15,
2002. Management does not believe adoption of SFAS No. 148 will have a material
impact on its results of operations.
Risk Factors
This report includes a number of forward-looking statements that reflect our
current views with respect to future events and financial performance. We use
words such as anticipates, believes, expects, future, and intends, and similar
expressions to identify forward-looking statements. There are important factors
that could cause actual results to differ materially from those expressed or
implied by such forward-looking statements, including:
. most of our sales are air data systems products, and we cannot be certain
that the market will continue to accept these or
9
our other products.
. we currently have a limited number of customers that use our products,
primarily for government-related contracts, making us reliant on these
customers and government needs.
. our business derived a large portion of its revenues from one military
retrofit program, which was substantially completed in the third quarter of
fiscal 2002.
. the growth of our customer base could be limited by delays or
difficulties in completing the development and introduction of our CIP or
other planned products or product enhancements.
. we rely on third party suppliers for the components of our air data
systems products, and any interruption in the supply of these components
could hinder our ability to deliver our products.
. our market in general and our customers have been adversely affected by
the events of September 11th.
. our government retrofit projects allow the government agency or
government contractor to terminate or modify their contracts with us.
. we depend on our key personnel to manage our business effectively, and if
we are unable to retain our key employees, our ability to compete could be
harmed.
. our revenue and operating results may vary significantly from quarter to
quarter, which may cause our stock price to decline.
. our revenues and operating results may vary significantly from quarter to
quarter due to a number of factors, including:
. variations in demand for our products;
. the timing of the introduction of RVSM requirements on various
flight routes;
. the capital expenditure budgets of aircraft owners and operators and
the appropriation cycles of the U.S. government;
. changes in the use of our products, including non-RVSM air data
systems, RVSM systems and flat panel displays;
. delays in introducing or obtaining government approval for new
products;
. new product introductions by competitors;
. changes in our pricing policies or the pricing policies of our
competitors; and
. costs related to possible acquisitions of technologies or
businesses.
. our inability to replace the KC-135 RVSM contract.
. our competition includes other manufacturers of air data systems and
flight information displays against whom we may not be able to compete
successfully.
. we may not be able to identify or complete acquisitions or we may
consummate an acquisition that adversely affects our operating results.
. our success depends on our ability to protect our proprietary rights, and
there is a risk of infringement. If we are unable to protect and enforce
our intellectual property rights, we may be unable to compete effectively.
Risks Related to Our Industry
If we are unable to respond to rapid technological change, our products
could become obsolete and our reputation could suffer.
Future generations of air data systems, engine and fuel displays and flat
panel displays embodying new technologies or
10
new industry standards could render our products obsolete. The market for
aviation products is subject to rapid technological change, new product
introductions, changes in customer preferences and evolving industry
standards. Our future success will depend on our ability to:
. adapt to rapidly changing technologies;
. adapt our products to evolving industry standards; and
. develop and introduce a variety of new products and product enhancements
to address the increasingly sophisticated needs of our customers.
Our future success will also depend on our developing high quality,
cost-effective products and enhancements to our products that satisfy the
needs of our customers and on our introducing these new technologies to the
marketplace in a timely manner. If we fail to modify or improve our
products in response to evolving industry standards, our products could
rapidly become obsolete.
Our products must obtain government approval
Our products are currently subject to direct regulation by the U.S. Federal
Aviation Authority (FAA), its European counterpart, the Joint Aviation
Authorities (JAA), and other comparable organizations. Our products and
many of their components must be approved by the FAA, the JAA or other
comparable organizations before they can be used in an aircraft. To be
certified, we must demonstrate that our products are accurate and able to
maintain certain levels of repeatability over time. Although the
certification requirements of the FAA and the JAA are substantially
similar, there is no formal reciprocity between the two systems.
Accordingly, even though some of our products are FAA-approved, we may need
to obtain approval from the JAA or other appropriate organizations to have
them certified for installation outside the United States.
Significant delay in receiving certification for newly developed products or
enhancements to our products or losing certification for our existing products
could result in lost sales or delays in sales. Furthermore, the adoption of
additional regulations or product standards, as well as changes to the existing
product standards, could require us to change our products and underlying
technology. Some products, from which we expect to generate significant future
revenues, including our CIP, have not received regulatory approval. We cannot
assure you that we will receive regulatory approval on a timely basis or at all.
Because our products utilize sophisticated technology and are deployed in
complex aircraft cockpit environments, problems with these products may arise
that could seriously harm our reputation for quality assurance and our business.
Our products use complex system designs and components that may contain errors,
omissions or defects, particularly when we incorporate new technologies into our
products or we release new versions or enhancements of our products. Despite our
quality assurance process, errors, omissions or defects could occur in our
current products, in new products or in new versions or enhancements of existing
products after commercial shipment has begun. We may be required to redesign or
recall those products or pay damages. Such an event could result in the
following:
. the delay or loss of revenues;
. the cancellation of customer contracts;
. the diversion of development resources;
. damage to our reputation;
. increased service and warranty costs; or
. litigation costs.
Although we currently carry product liability insurance, this insurance may
not be adequate to cover our losses in the event of a product liability
claim. Moreover, we may not be able to maintain such insurance in the
future.
We face risks associated with international operations that could cause our
financial results to suffer or make it difficult to market our products
outside of the United States.
11
We expect to derive an increasing amount of our revenues from sales outside
the United States, particularly in Europe. We have limited experience in
marketing and distributing our products internationally. In addition, there
are certain risks inherent in doing business on an international basis,
such as:
. differing regulatory requirements for products being installed in
aircraft;
. legal uncertainty regarding liability;
. tariffs, trade barriers and other regulatory barriers;
. political and economic instability;
. changes in diplomatic and trade relationships;
. potentially adverse tax consequences;
. the impact of recessions in economies outside the United States; and
. variance and unexpected changes in local laws and regulations.
Currently, all of our international sales are denominated in U.S. dollars.
An increase in the value of the dollar compared to other currencies could
make our products less competitive in foreign markets. In the future, we
may conduct sales in local currencies, exposing us to changes in exchange
rates that could adversely affect our results of operations.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's operations are exposed to market risks primarily as a result of
changes in interest rates. The Company does not use derivative financial
instruments for speculative or trading purposes. The Company's exposure to
market risk for changes in interest rates relates to its cash equivalents and an
industrial revenue bond. The Company's cash equivalents consist of funds
invested in money market accounts, which bear interest at a variable rate, while
the industrial revenue bond carries an interest rate that is consistent with 30-
day tax-exempt commercial paper. As the interest rates are variable, and we do
not engage in hedging activities, a change in interest rates earned on the cash
equivalents or paid on the industrial revenue bond would impact interest income
and expense along with cash flows, but would not impact the fair market value of
the related underlying instruments.
ITEM 4. CONTROLS AND PROCEDURES.
(a) Our principal executive officer and principal financial officer have
conducted an evaluation of our disclosure controls and procedures, as such term
is defined under Rule 13a-14(c) promulgated under the Securities Exchange Act of
1934, as amended (the "Exchange Act"), within 90 days of the filing date of this
report. Based on their evaluation, our principal executive officer and principal
accounting officer concluded that our disclosure controls and procedures are
effective.
(b) There have been no significant changes (including corrective actions with
regard to significant deficiencies or material weaknesses) in our internal
controls or in other factors that could significantly affect these controls
subsequent to the date of the evaluation referenced in paragraph (a) above.
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.
Each of our 6 non-employee directors received a grant of 3,251 shares of shares
of unregistered restricted stock on October 1, 2002. The grants were made
pursuant to the section 4(2) exemption under the Securities Act of 1933, as
amended.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K.
None
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INNOVATIVE SOLUTIONS & SUPPORT, INC.
Date: February 13, 2003 By: /s/ James J. Reilly
-------------------
James J. Reilly
Chief Financial Officer
(Principal Financial Officer)
13
CERTIFICATIONS
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Geoffrey S. M. Hedrick, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Innovative Solutions
and Support, Inc.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
February 13 , 2003
/s/ Geoffrey S. M. Hedrick
----------------------------
Geoffrey S. M. Hedrick
Chairman of the Board and
Chief Executive Officer
14
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, James J. Reilly, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Innovative Solutions
and Support, Inc.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
February 13, 2003
/s/ James J. Reilly
--------------------------
James J. Reilly
Chief Financial Officer
15